In a significant step towards convergence of globally accepted accounting standards, the Securities and Exchange Commission (“SEC”) has voted to adopt rules to enable “foreign private issuers” to provide financial statements based upon International Financial Reporting Standards (“IFRS”) without reconciliation to U.S. Generally Accepted Accounting Principles (“GAAP”). While immediately impacting many foreign public companies, the new position by the SEC signals a changing landscape for U.S. domestic public companies as well.
For more than four decades, foreign private issuers conducting registered U.S. offerings or registering a class of securities with the SEC have been required to reconcile their financial statements with U.S. GAAP if the financial statements were prepared under another accounting standard. This reconciliation generally involves identifying accounting differences and quantifying specific line item variations.
Historically, to justify reconciliation, the SEC has asserted (a) the need for comparable information when making investment decisions about domestic or foreign securities, and (b) the public interest served by allowing investments in diversified securities, including foreign securities. Yet in recent years, many foreign companies have decried the compliance cost associated with reconciliation, while policy makers have focused on maintaining the attractiveness of U.S. financial markets in the Sarbanes-Oxley era. International standards also have matured and studies have shown that U.S. investors do not depend substantially upon reconciliation.
Recognizing that U.S. GAAP should not be the exclusive source of accounting standards, the SEC now will permit foreign private issuers to file financial statements prepared in accordance with the English language version of IFRS as published by the International Accounting Standards Board (“IASB”). Issuers who rely upon other accounting standards must continue to reconcile their financial statements with U.S. GAAP.
Acceptance of IFRS reflects its advanced development. Since 2005, the European Union has required all listed European Union companies to prepare consolidated financial statements in accordance with IFRS. Many other jurisdictions including Canada, Israel, India, Japan, and China are set to adopt IFRS within the next few years. Still, the EU and other jurisdictions diverge in certain areas from the published IASB version.
In limiting its reconciliation-elimination position to the English language IASB version of IFRS, the SEC is seeking to encourage the development of a single IFRS application rather than a divergent set of standards applied differently in every nation. Indeed, a single standard should alleviate inconsistency of application through linguistic fluctuations and jurisdictional arbitrage. Some foreign private issuers still will need to reconcile their IFRS financial statements to the published English-language IASB version. The reconciliation, nonetheless, should prove easier in comparison to U.S. GAAP reconciliation.
To implement its new position, the SEC amended Items 17 and 18 of Form 20-F and made conforming amendments to Regulation S-X, Form F-4 and Form S-4, and Securities Act Rule 701. The reconciliation carveout will extend to interim financial statements—if a foreign private issuer voluntarily provides them or is required to, such as in a registration statement. Notably, despite the reduced compliance burden by foreign private issuers, the due date for an Annual Report on Form 20-F remains unchanged at six months after fiscal year end.
Although it will become effective 60 days after publication in the Federal Register, the new position will apply to financial statements covering fiscal years ended after November 15, 2007 (the date of the SEC adopting meeting). Therefore, foreign private issuers with calendar year-end fiscal years will be able to rely upon the new position promptly.
In addition, the SEC stated it will permit foreign private issuers to follow the EU's November 2004 exception to International Accounting Standard 39, which eliminated fair value and hedge accounting restrictions. This accounting standard is highly technical and impacts relatively few companies, primarily financial institutions. The SEC conveyed that this exception will apply only for a two-year transition period.
Elimination of reconciliation for IFRS represents an important step in the convergence to globally accepted accounting standards. It fulfils commitments made by the SEC and the U.S. Financial Accounting Standards Board (“FASB”) in various forms over the past decade setting forth a roadmap to convergence. More fundamentally, the new position lays the groundwork for two more far-reaching changes in the future:
- permitting U.S. issuers (including investment companies) to file financial statements in accordance with IFRS rather than U.S. GAAP
- replacing or combining U.S. GAAP with IFRS or some other uniform standard
Before adoption of either of these convergence steps, however, standard setters must resolve differences in the way the standards are developed, the specificity of those standards, the independence of the standard setters, and the auditing and enforcement mechanisms. Timing, training, and transition issues also are substantial. The SEC currently has a concept release outstanding with respect to the first bullet-point above. The SEC further is expected to announce additional roundtables in December 2007 to discuss convergence.
Many observers believe the multiplicity of implementation issues renders true convergence an unrealistic goal. Ironically, some critics of the SEC’s new position believe eliminating reconciliation will hurt rather than help advance convergence by removing an incentive to overcome different provisions. For both domestic and foreign issuers, it is a debate worth monitoring. Even if full convergence does not occur until the distant future, if at all, the promotion of the concept will influence how the IASB and FASB, as well as the SEC, implement new accounting rules and interpret existing ones.